Malinvestment can happen when incentives, like low costs of credit or an increase in the money supply, allocate more resources to an area of the economy than would naturally occur without the incentives. When the subsidizing begins, the everyday person loses the price signals that help them make better decisions. Once malinvestment happens, the correction can be brutal because the area subsidized must unwind and return to its natural state.
When you read those words, just think about the housing market a few years ago and your friends that worked supporting the housing and building industry (builders, construction workers, real estate salespeople, mortgage originators, bank employees, FANNIE MAE, FREDDIE MAC,…). Were they working like mad men a few years ago? Are they working today?
We are in the process of unwinding the boom artificially created by incentives and it may take years.
One alternative to the unwinding of the malinvestment, and the policy our country is currently supporting, is to keep fueling the problem with additional resources. When reading the previous sentence, think about TARP, stimulus bills Congress passed, and the low interest rates the Federal Reserve Bank maintains.
So, is the stimulus working? Of course not.
For the last few weeks I have been listening to Trey Parker, Matt Stone, and Robert Lopez’s Tony Award winning musical, “The Book of Mormon”. In the story, our lead character is pining to be sent to Orlando and its fake environments for his mission. Instead, he is sent to Uganda and must face a reality that he may not like.
Unwinding malinvestment is a reality that really hurts.
Read Professor Mario Rizzo‘s column to learn more about the problems and the challenges we still face. http://thinkmarkets.wordpress.com/2011/06/13/we-told-you-so/#more-4620